Clinton is confused about demand
People keep asking me to write something criticizing Hillary. OK, consider the following from Bloomberg:
Just last month, Hillary Clinton began including an idea in her speeches that suggests a shift in thinking for the Democratic Party: Wage growth may not just be good for the people who get a raise. It may be good for economic growth.
“It’s really simple,” she said at a rally in June in Ohio. “Higher wages leads to more demand, which leads to more jobs, which leads to higher wages.”
This is voodoo economics on steriods. Most economics textbooks are written by left of center economists, and yet I don’t recall reading this sort of argument in any of them. For good reason.
Even if wage growth led to more demand (it doesn’t), the Fed would simply raise interest rates enough to prevent demand from rising. I was especially disappointed to see some famous economists endorse her message:
“I think it’s a very marginal way of promoting economic growth,” says Robert Gordon, economist at Northwestern University who specializes in the subject. Like Summers, he prefers a massive investment in infrastructure. But he does agree that a shift in business income away from profits and toward salaries would create growth. Workers are more likely to buy things from their paychecks than businesses are to invest out of their profits.
For Gordon, “the question is, how do you get this increase in wage income?” He believes the best way for a president to raise wages is to let the Federal Reserve do it, by keeping unemployment low.
[Alan] Krueger agrees that the Fed has been able to improve wages, but says there’s more that politicians can do. A labor economist, Krueger has long been a proponent of a limited increase in the minimum wage. “I think the time could be right for a more virtuous growth model,” he said, “which is driven by stronger wage growth…more consumption, more demand, creating more jobs.”
Artificial attempts to raise wages merely serve to reduce AS. The Fed controls AD. That’s what the economics textbooks say, and they are right.
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1. August 2016 at 09:21
I’m pretty sure my Econ textbook did bring up marginal propensity to spend and fiscal multipliers. Sure, the Fed could try and off-set that . . . if they wanted to.
I do believe that broader consumption spending is more likely to produce job and productivity growth than businesses bidding down the returns and bidding up the price of the same set of assets. Especially if the latter makes them much more likely to exploit even marginal rent-seeking opportunities.
1. August 2016 at 09:33
The problem I’ve been lately reading about is the lack of business investment!
Anyway, sounds like New New Deal economics, and we know how that worked.
1. August 2016 at 09:50
You’re right, Sumner. Meanwhile, Trump correctly (though politically incorrectly) says (nominal) wages are too high!
BTW, I was very disappointed with Austan Goolsbee (if you’ve watched the DNC, you know what I’m talking about) refusing to overtly condemn protectionism. He’s sold himself out to the U.S.’s primary protectionist party!
1. August 2016 at 10:10
Scott, I’m utterly unqualified to challenge you on this post, but let me ask you this: What do you think the chances are that a president Hillary + a filibuster vulnerable Dem controlled Senate + a GOP controlled house will translate this “voodoo economics on steroids” into actual voodoo economics on steroids? And given that voodoo economics on steroids ARE implemented (to some degree), what do you suppose the chances are of reversing them before they do inordinate amounts of damage?
1. August 2016 at 10:14
In the Annals of Confused Economics, this is pretty awful;
http://www.bloomberg.com/view/articles/2016-07-28/answering-the-hardest-question-in-economics
——–quote——–
Gabaix’s idea seems to fit our experience with the zero interest rates. Nominal interest rates can never go very far below zero. In typical theories, this sends the economy nose-diving into a deflationary spiral. But in reality, economies that experience very low rates for many years — first Japan, and now the U.S. — seem to grow slowly and have low inflation, but not crash. In Gabaix’s model, that’s exactly what happens.
So what does Gabaix’s theory say we should do to boost the economy? Fiscal stimulus. When consumers are short-sighted, they will consume more of any windfall or tax cut they receive, which enhances the power of spending increases and tax cuts to increase growth.
Like all macroeconomic theories, Gabaix’s paper — which isn’t even in its final, published form — should be regarded as a thought experiment.
————endquote———–
Or as an idea that has been discredited many times already.
1. August 2016 at 10:47
“Higher wages leads to more demand, which leads to more jobs, which leads to higher wages.”
It is a quasi-Marxist point of view. Only Marx framed it that Profits = (Revenues – wages), and saw an inevitable spiral of falling wages leading to falling demand, and inevitable collapse.
1. August 2016 at 10:56
Makes perfect sense to me. If MPC out of wage income is higher than MPC out of capital income, then policies that raise wages should boost AD. If monetary policy is constrained, the greater AD could well offset efficiency losses from too high wages.
By a somewhat different mechanism, this would also have good results in a NK model at the ZLB. Here pushing up wages will boost inflation.
Of course, if monetary policy is not constrained, then you are correct that this is vulgar keynesianism, and simply flat wrong.
1. August 2016 at 11:48
I agree with Jonathon. Raising wages increases AD if you can do it without cutting jobs, and if there is a higher MPC for wage income. And if the economy is more demand constrained than supply constrained. And since I think that at least the last two of those are correct, and am not sure that raising wages has to necessarily cause a decrease in the numbers of jobs offered, and since I want a raise anyway, I am for that idea.
1. August 2016 at 14:11
Yes, Jonathon and Brown are correct that an increase in wages could increase demand, and thus output – if you believe AS is upward sloping.
You have to assume that the increase in the wage doesn’t also reduce AS so as to cancel the effect. What will happen is that prices will rise, transferring income from wealthier to less wealthier persons with higher marginal propensities to consume.
Thus, you also have to assume that you are not capital constrained – that a reduction in savings does not cause a likewise reduction in investment. Standard Keynesian assumption.
1. August 2016 at 14:15
This is right up there with how you declare that Bubbles can’t exist…
so the Fed will act “rationally” and cut off the rise in demand… hehehehe. Yeah… the Fed is real rational… that’s why we Have NGDP targeting now..
classical economists live in an alternate self constructed reality…
1. August 2016 at 14:23
What kinda interest rate hike do you think would be needed to stop the rise in demand caused by a 15 dollar minimum wage ? historically were pretty close to zero…
I don’t see minor hikes as having anything but a short term downward pressure on demand as big market players respond to the symbolic message in the hikes… small hikes wont effect the consumer classes consumption…they have a bunch of pent up demand to this day…
1. August 2016 at 14:34
I had the same thought as Patrick. “I” is in the equation that leads to this thinking. I don’t understand what leads some economists to treat marginal propensity to consume as: C increases with a fixed I. Is this really that elementary of a claim? It seems like it.
1. August 2016 at 15:37
Scott, being a libertarian, do you have an opinion on Gary Johnson?
He’s not perfect but he’s also a reasonable guy who seems to be willing to defer to an educated opinion if need be (he’s actually not totally bonkers on monetary policy, even though he wants to audit the fed).
1. August 2016 at 15:52
So why is the Fed raising interest rates when they have basically undershot their inflation targets for the last how many years?
1. August 2016 at 15:52
Send in the helicopters. Sikorksy, I love you.
Clinton evidently wants tight money and higher wages and multiplying perma-wars. Trump might be better but might be worse.
Now go vote.
1. August 2016 at 16:51
“the Fed would simply raise interest rates enough to prevent demand from rising.”
Only if the economy is at target inflation/NGDP or at full employment. You can’t assume the economy right now is where the fed wants it to be and therefore anything anyone else does will be offset, you can’t assume hyper central bank competence and effectiveness.
1. August 2016 at 17:18
Scott, being a libertarian,
ha ha ha
do you have an opinion on Gary Johnson?
The moderator’s down with Nazi wedding cakes.
1. August 2016 at 18:04
You should warn people, Scott, when you are wearing your libertarian hat rather than your monetarist hat.
Henry Ford must have been a communist, lol. He paid good wages, and it boosted consumption of his cars.
Yep old communist Ford. What are you libertarians smoking? Granted, now we have a global economy and it makes things more complicated.
But Scott, what if workers in the US were paid 1 dollar per hour? How would GDP roll then? If consumption is 70 percent of GDP, how would that work out Mr Part Time Libertarian?
1. August 2016 at 18:10
But Scott, you said one very real and concerning thing. The Fed does not want increased demand. That could start inflation that they could not control, and then, what? They would be forced raise interest rates and destroy the banks and counterparties with all their pricey bonds being worth less. So, instead of that, the moment demand picks up, the Fed will raise rates.
So, the Fed wants the average US citizen to be just a little above water.
1. August 2016 at 18:16
Brett, You said:
“Sure, the Fed could try and off-set that . . . if they wanted to.”
You have heard of inflation targeting, haven’t you?
Patrick, Yes, a lot like the New Deal.
Harding, You said:
“Meanwhile, Trump correctly (though politically incorrectly) says (nominal) wages are too high!”
That must be why he’s proposing a big increase in the federal minimum wage.
And please stop throwing softballs over the plate, I’m getting bored.
Tom, I predict that the next GOP Congress will vote to increase the minimum wage rate.
Jerry, You said:
“Raising wages increases AD if you can do it without cutting jobs,”
You can’t.
davidw, You said:
“Standard Keynesian assumption.”
Don’t you mean pre-1980s Keynesian assumption?
Bill, It’s not about the Fed being rational it’s about the Fed thinking it’s rational. And they most certainly do think they are rational. And it would not help boost AD even if they didn’t offset it.
Kevin, I did a post on the article Patrick linked to.
Anthony, Yes, I like him and I will vote for him. Unlike some commenters, I do not regard Nazi wedding cakes as America’s biggest problem.
JMCSF, They are targeting expected future inflation.
Britonomist, It’s equally likely to be above or below where the Fed wants it, so no effect is the standard baseline assumption. You gotta better one?
1. August 2016 at 18:43
Good post, any thoughts?
http://jpkoning.blogspot.com/2016/07/monetary-policy-as-system-of-connected.html
1. August 2016 at 20:22
“That must be why he’s proposing a big increase in the federal minimum wage.”
-It’s $10 relative to $15. Less than half the size of the Democratic proposal. That’s not “big”. And it’s an obvious ploy to get elected. Most Republicans support raising the minimum wage to $10. The fact Trump held off for so long on it indicates he’s no strong supporter of a higher minimum wage at heart.
“Tom, I predict that the next GOP Congress will vote to increase the minimum wage rate.”
-Only if Trump wins.
“And please stop throwing softballs over the plate, I’m getting bored.”
-Build the wall.
Make America Great Again!
1. August 2016 at 20:39
Gary Anderson:
I don’t think anyone’s claiming that paying higher wages doesn’t make it easier to attract and retain good workers or that a motivated workforce isn’t more productive than an unmotivated one. The question is whether increasing wages leads to higher demand.
If Henry Ford had been in the horse and buggy business and not the automobile business and he had tried to double wages and shorten the work week, he might not have fared as well as he did. And if he had tried to do it in 1933 instead of 1914, he also might not have fared so well. And I doubt it would have gone any better if the wage raise were government mandated.
And, for the record, Ford car sales tripled the two years before he raised wages and increased 2.5x in the two years after he raised them.
1. August 2016 at 21:19
I totally agree with you Carl, which is why the move now to up the minimum wage in the face of years of dragging their feet may end up boosting the economies in selected cities.
If people don’t borrow you need to figure out other ways of getting money into their hands. Robbing small business may not be so good. But big business is hoarding cash and it is useless, but they don’t trust the banksters, err I mean bankers.
1. August 2016 at 21:24
“Raising wages increases AD if you can do it without cutting jobs,”
You can’t.
It happens all the time, wages are boosted and jobs are not cut. NPR says you are not telling it right, Scott Sumner: http://www.npr.org/sections/thetwo-way/2014/07/19/332879409/states-that-raised-minimum-wage-see-faster-job-growth-report-says
I think if you keep doing it it will have an effect, but wages have been held down, artificially, for so long….
1. August 2016 at 21:54
Scott Sumner, isn’t NGDP targeting basically the same as targeting nominal national income? And isn’t more or less 60-70% of nominal national income wages? You have been arguing for years that the government (ok the Federal Reserve Bank part of the government) not only has the ability to affect nominal income, but that it in fact should do that in order to make us as a group better off. Is it wrong to target the larger part of national income- wages? Why can’t that be done? Why would nominal income targeting have to be done through asset markets rather than labor markets?
1. August 2016 at 22:53
See how Sumner lamely rebuts davidw and Britonomist, who both make excellent points? Against davidw, Sumner simply says davidw’s model is pre-1980s, as if paleo-Keynesianism is obsolete (it is not, if anything the Lucas critique is obsolete now that behavioral economics has discovered bounded rationality). Against Britonomist, Sumner makes the howler that today perhaps AD is above normal (!). What planet Sumner? Let’s see how Bozo replies to Jerry Brown.
And Sumner fails history too: as Gary Andersen points out, Ford paid good wages so workers would buy cars (a significant percentage of cars were bought by workers) as well as to cut down on absenteeism and make for better workers. Sumner’s supporters seem like children trying to win over the teacher with off-topic posts and sucking up, like B. Cole, Kevin Erdmann and the sometime K. Duda.
@B. Cole – as we discussed a while ago, Spanish New World silver failed to halt the decline in real wages in Spain after the Black Death rise. So any wealth in Spain did not help the Spanish worker, at best it simply helped finance a sort of “Dutch Disease” (sic, I know about Spain invading the Netherlands) where any New World wealth was dissipated in harmful wars. Repeat after me: money is neutral, and the Fed printing more of it via a helicopter drop won’t change things much, even if the world is now clamoring for more dollars (which is dubious).
2. August 2016 at 04:23
Ah that’s OK, that is a nice, safe criticism. Good. Nothing to get worried about.
Most politicians say the same general idea, since the economics of the state is vulgar Keynesianism.
When Summer starts juxtaposing Hillary and Irma Grese, or Hillary and Elizabeth Báthory, then we’ll know Sumner isn’ just pandering.
2. August 2016 at 05:28
Ray Lopez: Even counterfeit money is not neutral.
There is good reason to believe the American West was developed with the help of counterfeit money.
2. August 2016 at 05:52
@ssumner:
I think that one difficulty with “the Fed will offset it” is that the Fed can only target national statistics, whereas the economy is heterogeneous.
As a hopefully less controversial example, look at Europe. The ECB can obviously act to offset Euro-wide inflation, but that doesn’t change that Greece, in particular, is suffering from an aggregate demand shortfall. Supplying AD to that region would increase the region’s (and hence Europe’s) output without significantly increasing the Euro-wide inflation rate.
The inequality-driven secular stagnation argument is similar, but it obviously makes its distinctions along income lines rather than geographic lines. If policy effects a transfer from agents who are not liquidity-constrained to those who are liquidity-constrained, then output might increase without inflationary effects.
I’m not entirely sure I buy this – it would seem to require that the low-wage economy operate a bit like a closed economy to avert “import leakage” from other sectors – but I think it would take a more complete model than “monetary offset!” to debunk.
2. August 2016 at 06:13
Jerry, Scott Sumner is a monetarist and a libertarian. They don’t mesh at all. So, he could be saying two different things, you know, like Trump often does. Your point about labor inflation versus asset inflation makes sense to me. Since 70 percent of GDP is consumer driven, you would want more purchasing power, but Scott says the Fed won’t allow that.
So, raising GDP by making the rich richer is all that Mises, err, I mean, Sumner has left. Using monetarism to further libertarianism is kind of evil.
2. August 2016 at 06:20
@Ray Lopez
“And Sumner fails history too: as Gary Andersen points out, Ford paid good wages so workers would buy cars (a significant percentage of cars were bought by workers) as well as to cut down on absenteeism and make for better workers.”
This is hilarious- you basically refute your own point in the same sentence. No firms primary motivation for paying its employees a “good wage” is so that their employees can turn around and purchase the goods they are consuming. Obviously that can be a positive by product of paying “good wages” for the firm.
There are a multitude of reasons why a company may pay above industry standard wages- you’re trying to attract the best talent, you’re trying to keep employee retention high (turnover can be extremely costly), maybe you’re trying to soak up as much of the professional workers as possible to prevent them from working at competitors. I guarantee no firm is hiring employees going, “let’s pay them more so they have more money to spend on our products”…
2. August 2016 at 06:58
Travis, Thanks, that’s excellent.
Harding, That’s right, a 38% boost in a period of 1.5% inflation is not big. And Hillary is proposing $12.
Jerry, Yes, you can target wages, but it has nothing to do with making workers better off, the goal is to smooth out the business cycle. The Fed does not determine real wages, except in the very short run.
Ray, Thanks for putting a smile on my face. And so Mr. “Short run money neutrality” defends the old Keynesian model.
A monkey at a typewriter. . . .
Majromax, You said:
“Supplying AD to that region would increase the region’s (and hence Europe’s)”
Yes, it boost Greece’s AD, but not the eurozone’s
2. August 2016 at 08:49
“That’s right, a 38% boost in a period of 1.5% inflation is not big.”
-Relative to a 100% boost, no.
“And Hillary is proposing $12.”
-The platform says $15 “over time” (whatever that means):
https://www.reddit.com/r/hillaryclinton/comments/4ryo4i/democrats_add_15_minimum_wage_to_platform/
Somebody should ask Her whether she has updated Her position. But everyone knows she’s the least accessible candidate by the press.
2. August 2016 at 09:05
Gary Anderson,
The people NPR quoted are right — that Department of Labor data settles nothing, and you have to look at the (voluminous) literature on the minimum wage.
The piece cites Dube and Neumark, but there are countless others.
There was a study out about a year or two ago that showed pretty good evidence from Canada (which has been raising and lowering its minimum wages at the province level for decades) that at least in Canada, policymakers’ decisions about the minimum wage are an endogenous function of macroeconomic conditions — if unemployment is low, wage growth is strong, and inflation can be expected to rise, for example, then an increase in the nominal wage may be in order because it won’t mean much of anything in real terms (but you still get political credit, if you’re a policymaker, for raising it).
Of course a) Scott wasn’t making any claim about the minimum wage and unemployment, he was talking about the minimum wage and aggregate demand, so no he’s not “not telling it right,” and b) any discussion of the minimum wage should really be accompanied by at least some mention of a wage subsidy, negative income tax, EITC, or some other alternative to the minimum wage (i.e., the debate should not be about raising vs. not raising the federal minimum wage, or raising it to $10 or $12, but about the optimal public policy from the full set of available policies).
…just like any discussion of aggregate demand should be accompanied by at least, at a bare minimum, some mention of the Fed’s reaction function, to get back to Scott’s original point.
2. August 2016 at 09:12
PS — I forgot to mention the relevance of that Canada study to the NPR piece: if policymakers decide whether to raise or lower the minimum wage, whether knowingly or not, in response to macroeconomic conditions, then that alone can explain 100% of the data in the report, i.e. growth can be stronger in states that raised their minimum wages than those that don’t, *AND* at the same time the minimum wage boosts unemployment (or reduces future wage growth, or if you like there are other possibilities…).
That is just one possible way that you can find a correlation moving in the opposite direction as causation. (Cue Scott saying “Interest rates are not a reliable indicator of the stance of monetary policy…”)
2. August 2016 at 09:15
“Yes, you can target wages, but it has nothing to do with making workers better off, the goal is to smooth out the business cycle. The Fed does not determine real wages, except in the very short run.”
Thanks, that is a good answer and I think I understand your view. I would just say that when the Fed is not (for whatever reason) doing its job of keeping output at potential, and missing on the downside of that, I believe that most workers are probably going to lose bargaining power with regards to their wages, and that can influence their real wages. In other words, in the absence of full, full employment workers will have a difficult time capturing more of the value of their input. So maybe I’m not talking about the total of NGDP so much as about the percentage of that NGDP going to labor. And I think that in a full employment economy that percentage can be higher. And that policy can affect that ratio.
I also have a request of you. Would you consider posting some time about the effects of different NGDP level target rates? I mean like the difference between a 3% growth target and a 6%. Or if you have done that could you point me to that?
2. August 2016 at 15:31
“Britonomist, It’s equally likely to be above or below where the Fed wants it, so no effect is the standard baseline assumption. You gotta better one?”
You could have plausibly said this in the past, this is not a plausible statement in todays environment. In the era of secular stagnation and lowflation.
2. August 2016 at 16:12
Jerry, I’ve done some posts on that, but I can never remember where. I’ll do them again at some point. It’s not a huge difference, if done right.
Britonomist, The era of lowflation has no bearing on whether the Fed’s response to demand shocks is asymmetrical.
You may think the Fed made a mistake raising rates in December (I do too) but they did, which indicates they are worried about inflation.
2. August 2016 at 23:36
Sumner: “Ray, Thanks for putting a smile on my face. And so Mr. “Short run money neutrality” defends the old Keynesian model.” – no, I rebutted your point, not refuted mine: “Against davidw, Sumner simply says davidw’s model is pre-1980s, as if paleo-Keynesianism is obsolete” – paleo-Keynesianism is alive and well (Martin Wolf of the FT believes in it), even if I don’t.
4. August 2016 at 07:02
– Yes, higher wages DO lead to more demand. Especially people with lower wages will be able to spend more. The problem is that more demand allows producers to increase prices, creating (higher) PRICE inflation.
– No, in the CURRENT situation people are not inclined, not in the mood to spend more of those wage increases. They will take advantage of their higher wages to pay down debt (more).
– No, the FED does NOT raise rates to combat inflation. The FED FOLLOWS the 3 month T-bill rate.
– I would pour A LOT OF money in the maintenence of the EXISTING infrastructure and ZERO money in the building of NEW e.g. roads, railways & bridges.
16. August 2016 at 05:02
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